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Is There an Alternative for Investors Starved of Retail Bonds?

Philip Gilbert - Head
of Fixed Income at Beaufort Securities

The low interest rate environment of recent years has made the hunt for
yield more difficult and as I highlighted in the last edition of DIY
Investor Magazine, demand from investors for retail bonds has outstripped
supply leaving investors frustrated by the shortage of issuance.

The London Stock Exchanges’ Order Book for Retail Bonds
(“ORB”) is considered the blue chip listing because it represents the benchmark
for transparency and disclosure that retail investors should expect and it has
become the listing of choice for the buyers and distributors of retail bond
issues.

This transparency and disclosure comes from the supporting
documents to the issue, specifically the prospectus and information booklet
required by the exchange. Regulation requires that the prospectus is the lead
document, the information booklet “follows” and is intended to provide a
summaryto help retail investors
understand the relevant points, but it must not be viewed as a substitute for
the prospectus.

There are a number of reasons for the lack of issuance on
ORB; one is the perception that the coupon needs to “start with a 6”, and another
is the re-emergence of the banks in lending to firms that had turned to ORB as
a source of funding. At the same time, the listing has become harder to attain
for new issuers as it is intended for only the most vanilla bonds.

One of the prime tasks for managers of a bond issue is
successfully distributing the paper. Many of the traditional investors of
retail bonds prefer issue size to be at least £50m. Whilst this may be small
compared to the institutional bond market, where benchmark size is at least
£200m, it is well in excess of the funding requirements of many potential
issuers, or it is more than they need from a single issue.

Beaufort Securities Limited (“Beaufort”) is typical of a
number of firms who meet potential issuers with successful businesses whose
funding requirements are deemed “too small”.

These companies have been recognised by Standard &
Poor’s who have created a Mid-Market Evaluation process that allows them to
potentially rate these firms.

Beaufort has been exploring alternative listing venues, for
example the LSE’s Order Book for Fixed Income Securities (“OFIS”), or the Main
Market of ICAP Securities and Derivatives Exchange (“ISDX”). Both of these
alternatives can enable us to better serve our clients in issuing public debt
which, in turn, should lead to a greater supply of bonds for investors to
consider.

A number of issuers do want larger amounts of funding, some
in excess of £100m, but not all in one go. An example of this is an issue we
are currently managing for Indian Solar Energy PLC, the Borrower and Guarantor
is Nereus Capital Investments (Singapore) Private Limited. Their funding
requirements over the next 2-3 years are up to £200m, to provide this they have
established a Medium Term Note (“the Notes”) Programme

A Programme, unlike a single issue prospectus allows them to issue
noteson an on-going basis without producing an individual
prospectus for each issue. Instead, the programme is amended or supplemented on
an on-going basis, including at the time of each issue. For an issuer such as
Indian Solar Energy PLC the establishment of a programme becomes very cost
effective, and shortens the time it takes to bring an issue to market.

It is not unusual to have a newly formed company as the Issuer, with a
loan between them and a guarantor who actually uses the proceeds of the issue.
The issuer has no assets other than the loan agreement and the collateral
pledged to cover the loan.

In this instance, the collateral includes a pledge of all the
outstanding shares of the Borrower and appropriate negative covenants ensuring
100% indirect ownership and control of the Lead Assets, which are the Dubbak
Solar Projects Pvt. Ltd, and the Medack Solar Projects Pvt. Ltd

Dubbak has leased approximately 27 acres of land
from the firm contracted for doing the engineering, procurement and
construction (EPC)works of the 9.20MWp
project in Telangana State

Medak will own 39 acres of land and has executed an
EPC contract for the development and construction of a 8.24MWp solar power
project.

Beaufort will continue bringing such issues to market next year in an
effort to achieve a broader retail bond market, with an increasing supply,
whilst maintaining the standards of transparency and disclosure referred to at
the beginning of this article.

Low interest rates in recent years have made the hunt for yield more
difficult. Whilst 2016 does appear to be the year wheninterest rates finally start to rise, there
is expectation that the “new norm” for rates will be lower than in years gone (1)
by, reflecting the low inflation environment we are currently experiencing
in-spite of all the global quantitative easing.

Dividends have, for many years, been a very good source of income for
investors, however recent reductions by firms such as Tesco, Standard
Chartered, and Rolls Royce endorse what should be known; dividends cannot be
relied upon to provide a fixed level of income.

In conclusion, we hope that our efforts will allow investors to access
a wider universe of bonds, which have a high level of disclosure and
transparency, enabling investors to further diversify their portfolios.